Managing Political Risk in International Business

Political environment could involve a risk to businesses, domestic and foreign. Such risk is called political risk. Political risk is that perception by the businesses that their interests will get deteriorated when certain political upheaval happens. Political risk can occur in both democracies as well as in the totalitarian set ups as well.

Political Risks are of different types. There are micro and macro political risks. Micro political risk is the one that affects a particular firm or class of firms. Usually firms owned by one class of businessmen, say, the foreigners from certain country, a particular business family or region/state. Micro political risk risk can be hedged. Macro political risk affects all. There is no sparing of any business, any nationality, any trade or industry.

Formulating and Implementing Strategies to deal with Political Risk

The following course of action, suggested by John D Daniels and Lee H Radebaugh will help in dealing with political risk.

  1. Identify the issue: The problem may be boycott, threat of confiscation, damage to property, imposition of countervailing duty or new labor standards or so.
  2. Define the political and other aspects of the issue: Is the concern of the Government or political group serious one or just minimal? Is there any hidden force or hidden agenda?
  3. Was there any past upheaval like this? What was the outcome then? What would be the political fallout if the government sides with the firm or sits opposite? Is there a possibility to settle the issue outside politics? Answers to these question answer the issue.
  4. Assess the potential political action by other firms and the special-interest groups: who are all other parties like us affected? What are their reactions? Will they apt for a coalition of all to mount pressure? How strong are the special interest groups in putting a united face to tone down the issue?
  5.  Identify important individuals or institutions: Who are the individuals ( Public Leaders, Politicians, Elected Representatives, Regulatory Institutional Heads)? What are the institutions involved and what are their bargaining powers?
  6. Formulate strategies: What are the key objectives and minor objectives of the firm in responding to the issue? What are the strategies? To cede? To supersede? To recede? How to break the ice? How to establish contact? How to make the offers of conciliation and reconciliation? Evolve alternative strategies for dealing with affected and aggrieved. Evolve alternative strategies for dealing with those in the front-line of confrontation.
  7. Determine the impact of implementation: What will be the outcome of ceding? What will be the outcome of superseding? What will be the outcome of receding? Financial, Corporate Image, and Relational impacts need to be addressed.
  8. Select the most promising strategy: A clear evaluation of the overall costs and benefits of strategies need to be made on Financial, Corporate Image, and Relational impacts. Order and choose the right strategy set.

Handling Political Risk

Political risk handling has to be addressed at following phases:

  1. Pre-investment planning phase,
  2. Post-investment operating phase and
  3. Post expropriation phase.

1. Handling political risk in the pre-investment planning phase

To deal with political risk at pre-investment level, a business concern can think of following strategies:

  • Avoidance: Avoidance involves not committing the resources in the project. This is easiest but not reflective of true business class. However certain politically high risky states/nations/ regions have to be avoided, because one cannot lose investment itself in the hope of making a return on investment.
  • Insurance: Insurance involves taking insurance cover for people and property of the business concern or project in the hostile country. In developed nations political risk insurance policies are available which the MNCs can buy to cover investments in risky countries. Third world countries also have overseas business risk insurance outfits. Policies that provide for a maximum insured amount and a current insured amount are available. Premium is payable on the current insured amount at usual rates and on the difference between maximum and current insurance amounts, called standby insurance level, a nominal rate of premium is charged.
  • Negotiating the Environment: A business concern and the Government negotiate on the rights and responsibilities of both and abide by the ‘concession’ agreement reached. But new rulers may repudiate ‘concession’ agreement agreed to by the past ruler. Such repudiation happens in democratic countries as well.
  • Structuring the Investment: The investment in the project in the host country can be structured in such way that host government intervention costs the Government exchequer heavily. This is achieved by adjusting production, transportation export,technology transfer and financial policies. The foreign project may be just an assembling unit or a just a part manufacturer.
  • Patenting: The MNC can register its patent generally and make for host countries difficult to infringe patent rights or trade mark rights.

2. Handling political risk in the post-investment operating phase

After investment is made, through operating policies, political risk can be managed. The alternatives are: Short term profit maximization, Changing the BCR of expropriation, Developing local stake holders and Adaptation.

  • Short-term Profit Maximization policy involves stressing that investment made is quickly paid back. On finding the political environment hot, the firm can go for a policy of quick realization by avoiding further commitments in the project. A posture such as this itself may alter the host government’s attitude as capital flights are unaffordable in these days of globalization. Shorter Payback Period: According to this method, projects with shorter payback period are normally preferred to those with longer payback period. The Finite-horizon Method: This method is similar to payback method applied under the condition of certainty. In this method, a terminal date is fixed. In the decision making, only the expected returns or gain prior to the terminal date are considered.
  • Changing the Benefit/Cost Ratio (BCR) policy involves the firm adopting a pro-host country, increased benefit and decreased cost policy. Policies such as establishing local R&D facilities, export-thrust, technology transfer etc., will help the MNC buying peace with adversaries.
  • Developing local stake holding policy involves, the firm concerned creating a customer base, a local investor base, supply-chain base, etc so that expropriation/confiscation will be resented to by local customers, investors and channel partners. It must be noted while 100% subsidiaries face nationalization threats, joint-venture do not suffer such threats.
  • Adaptation policy involves adapting operating policies to the dictates of the political boss. If expropriation is pressed, the MNC can opt for management contracts or franchising so that operational aspects are not handled by the MNC.

3. Handling political risk in the post-expropriation phase

In the post-expropriation phase, damage control and benefit harvesting exercises need to be pursued. Negotiation, Power leveraging, Legal recourse and Surrender are the options.

  • Negotiation: After the expropriation/confiscation, continued contacts and negotiation with the Govt. help in harvesting more benefits.
  • Power Leveraging involves the firm applying power on the government through diplomatic channels, trade bodies, etc for speedy harvesting.
  • Legal Recourse involves resorting to legal remedies to recover the value of property that are confiscated. This is a long-drawn-cut remedial course.
  • Surrender policy involves giving up the above referred to courses and agreeing to salvage the investment.

Credit: International Business Environment-MGU MBA

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